Minnesota owes more than $1 billion to the federal government, and businesses across the state fear they could get hit with the bill.

More than a quarter of Minnesota's workforce filed for unemployment benefits in the year after the COVID-19 pandemic swept the nation, draining $1.5 billion in the state trust fund that supports sidelined workers. Minnesota then borrowed more than $1 billion from the federal government to keep the unemployment payments coming.

Now, a political clash is brewing over how to pay back the debt and replenish the trust fund. Business owners are urging state leaders to act fast to limit a looming tax hike.

"It could be absolutely devastating," said Minneapolis Regional Chamber of Commerce President Jonathan Weinhagen. If unemployment insurance payroll taxes spike to cover the costs, Weinhagen said that would hit small businesses hardest. "This is really money right off of the bottom line, which hasn't looked really great for the last two years."

The debate over the unemployment insurance debt escalated last week as budget officials announced a historic projected $7.7 billion state budget surplus over the next two years. Repaying the debt — and whether to use the surplus, federal aid or other means to handle it — could be one of the biggest issues lawmakers grapple with in the coming legislative session.

"We'll get that one in negotiations. We'll get that one fixed," DFL Gov. Tim Walz said Tuesday. He declined to comment on whether he would use federal pandemic relief dollars, saying, "I'm not going to do specific negotiations with myself."

Minnesota is among nine states and the Virgin Islands that owe the federal government a combined total of about $39 billion, and is paying interest on the debt.

"We will continue to work with other states in similar positions to see if there are congressional resolutions possible," said Department of Employment and Economic Development (DEED) spokeswoman Jen Gates.

She said state officials have been in contact with Minnesota's federal delegation throughout the pandemic about ways Congress can help states with unemployment insurance trust funds, but there's been little sign of congressional action on that front.

Meanwhile, DEED is set to release its new unemployment insurance tax rates for employers Wednesday. They take effect Jan. 1, but employers' first payment under the new rates wouldn't be due until April, Gates said.

Minnesota should follow other states that have put some of their federal pandemic relief money toward unemployment costs, said House Minority Leader Kurt Daudt, R-Crown. The conservative-leaning Tax Foundation reported in September that 31 states had put some portion of their funding from the past two federal COVID economic packages toward replenishing their unemployment trust funds.

"If the governor does not take action he will be responsible for a 15% tax increase on small businesses all across the state of Minnesota," Daudt said. "I think that's unconscionable at a time when our state has a $7.7 billion surplus."

Democratic House Majority Leader Ryan Winkler said his colleagues want to make sure small and struggling businesses are able to get tax help or other aid, potentially through the state devoting a chunk of money to the unemployment insurance trust fund.

"But we are not interested in providing a big tax benefit for large corporations that don't need it," said Winkler, DFL-Golden Valley. "And so we will have to think about pretty quickly how to work with the business community, work with Republicans, to target help to businesses that are struggling in this environment."

The latest budget surplus from Minnesota Management and Budget predicted that U.S. corporate profits would grow by 19% in 2021, nearly four times the rate forecast in February.

Mike Flynn, an investor and operator of the Whitewater Travel Plaza in St. Charles, is among the small business owners urging state officials to act.

Flynn said his restaurant was closed for roughly seven weeks during the peak of COVID-19 cases last year. Now they are short-staffed and trying to find people to fill open positions. He is still trying to figure out what the payroll tax rate increase could mean for the Travel Plaza's finances, and worries payments could stretch on for several years before the fund is replenished to pre-pandemic levels.

"In a small business, that's a big deal," Flynn said. "Using some of the stimulus money to replenish that fund is very justifiable in my mind."

While the final payments aren't due for several months, he said business owners are already planning months and years ahead. Last year, lawmakers quarreled until July over tax cuts for businesses that got Paycheck Protection Program loans to help them weather the pandemic.

"That's been a frustrating part of Minnesota government lately," he said. "Businessman have to plan way ahead, years ahead, and here we are right on the cusp of this thing."

With the entire Legislature and the governor up for election in 2022, Weinhagen said politics could complicate attempts to find a quick solution. Despite the partisan divisions and the high demand for a piece of the $7.7 billion, Weinhagen said he is hopeful lawmakers will reach an agreement to use some of the largest surplus in state history on the unemployment insurance problem.

"The biggest concern that I hear from small businesses is that uncertainty is the very worst thing, and they've been living with uncertainty for such a long time now," he said. "The longer this thing looms the harder it is for businesses to plan."